We have read your response to our
economists’ letter of March 30, which claims to refute “imprecise and false
macroeconomic statements.”

We note that your response does not
challenge any of the facts stated in our letter, nor does it show anything in
our letter to be overstated, misleading, or exaggerated. In fact, it challenges
only a few sentences, mostly by misrepresenting what we actually wrote.

For example, you state:

“The
authors also mention that the fall in GDP per capita from 1980 to 2000 is
explained entirely by the loan agreements with the IMF.”

But we did not say
anything remotely like that. In fact, the IMF appears just twice in our letter,
in these two sentences:

“From
1980 to 2000, a period during which Ecuador had a number of loan agreements
with the International Monetary Fund, Ecuador experienced a considerable
economic failure, as GDP per capita fell by 1.5 percent
over those two decades.”

And:

“For example, a 2002 law supported by the
IMF and World Bank required that Ecuador’s Stabilization Fund, an entity
created with, and which received, revenues from oil exports, spend 70 percent
of its revenues on debt payments, but just 10 percent on social spending.”

The reader can infer that the IMF may have
contributed to this unprecedented long-term economic failure — which it did —
but by no means does it say that the whole disaster is “entirely explained by
the loan agreements with the IMF.”

Your response also states: “Arguing that Correa’s administration has implemented
countercyclical fiscal policy could not be further from the truth.”

Our letter mentions counter-cyclical
fiscal policy in just this one place:

…innovative
and important reforms that the Ecuadorian government has enacted that have
played an instrumental role and allowed the country to emerge, relatively
unscathed, from the 2009 Global Recession and the more recent collapse in oil
prices. These reforms included bringing the central bank into the government’s
economic team, a tax on capital exiting the country, a large increase in public
investment, re-regulation of the financial sector, and counter-cyclical fiscal
policy.

You object that fiscal policy was not
generally counter-cyclical during the decade, but as can be seen clearly above,
we did not say that it was. There was indeed a large fiscal stimulus (see
below) that counteracted the 2009 recession, and so the statement quoted above
is true. (We address your claim of pro-cyclical fiscal policy in greater detail
below.)

This takes care of your objections to what
we actually wrote. Now, you also raise some issues in which you present your
own interpretation of the data of the past 10 years. This is another story, and
something that we examine below. But please note that none of what you wrote
supports your completely unsubstantiated and rather reckless claim to “refute the imprecise and false macroeconomic
statements (or the so-called ‘alternative facts’) presented” in our letter.

You
noted that the growth of GDP per capita from 2000 to 2006 was faster than the
growth over the last decade. However, it is not
impressive that you can find a six-year period (2000–2006), in which
annual per capita GDP growth was faster than during the last decade. The years
2000–2006 began with a recovery from a very deep recession (see below). By
comparison, Correa’s term began with an economy that was near the peak of the
prior 2000–2006 expansion; and the Correa decade also had two major oil price
collapses, one of which, as noted above, came with the world financial crisis
and recession. Given these conditions, and comparing as we did to the entire 26
years prior to the Correa government, it is fair to say that the growth record
of the past decade is a substantial improvement over the past.

You state:

During
Correa’s administration, oil prices
explain not only Ecuador’s economic growth but also the economic downturns.
The correlation between real GDP growth and oil prices during that period is
0.94. In contrast, between 2001 and 2006 the correlation falls to 0.27. Graph 1 shows the real GDP growth and
the WTI price from 2001 to 2016. [emphasis added]

This is a strong statement that Ecuador’s
economic growth during the Correa decade is simply a result of an increase in
oil prices. There is little doubt that an increase in oil prices will generally
contribute to increased GDP growth for an oil-exporting country. However, there
are a number of ways in which an increase in oil prices can impact economic
growth, and most of them can be greatly affected by government policy. If the
government were to increase royalties or taxes on foreign-owned production that
enable it to capture more of the windfall gains domestically, and if the
government were to spend increased tax revenue from both foreign- and
domestically owned production that would otherwise not have contributed to
domestic aggregate demand, this would contribute to economic growth. In fact,
the government’s oil revenues adjusted
for changes in the price of oil tripled from $1.85 billion in 2007 to $5.4
billion in 2016.[1]

If the government during this period makes
it more difficult for capital to leave the country by taxing capital flight,
this would also increase the impact of the oil windfall on economic growth. And
of course expansionary fiscal and monetary policies can also contribute to
growth. The Ecuadorian government enacted all of these policies and more
(see below) under Correa; but you appear to assume that these policy changes
had no positive impact on economic growth.

There were other counter-cyclical policies
that also contributed substantially to economic growth during the Correa years:
for example, the import tariffs implemented beginning in March 2015 under the
WTO’s rules for a temporary balance of payments safeguard added approximately 7.6 percent of GDP
over two years.

Furthermore, you make this extreme assertion
that the rise in oil prices is, by itself, the explanation of Ecuador’s
economic growth over the last decade, on the basis of nothing more than a
correlation between oil prices and GDP growth. This is clearly insufficient to
support your claim.

Figure 1A illustrates a correlation
between oil prices and GDP growth. However, although oil prices produce a
windfall in the oil sector, there is no guarantee that this would result in
increased oil production, and without increasing real oil production, oil that
sells at a higher price does not by
itself raise real GDP. Ecuador is a member of OPEC — a cartel that aims to
control oil prices through production agreements. Thus, we may expect some of
the windfall to be a consequence of forgoing significant increases in
production. Furthermore, windfall profits in oil may be captured by foreign
investors, or spent on increased imports rather than stimulating
demand for production in domestic non-oil sectors. The observed
correlation between real GDP growth and oil prices is not enough to tell us
what happened.

We can see this from Figure 1B below,
which shows a similar correlation between import prices and GDP growth.

Figure
1B: Annual Real GDP Growth and Import Prices 2000–2016

Source: Central Bank of Ecuador and
authors’ calculations

If we look at the direct contribution of
the petroleum sector to real GDP growth, it has not been large during the
Correa administration. Rather, there were significant increases in this
contribution to growth in the years prior — particularly in late 2003 and early
2004. This can be seen in Figure 2.

Figure
2: Contributions to Growth from Petroleum-related Sectors

Source: Central Bank of Ecuador and
authors’ calculations

Of course, the increased oil prices can
also have an indirect effect on real GDP growth. And as noted above, the
policies of the Correa government in capturing the windfall from the rise in
oil prices, and spending it, were a substantial part of this indirect effect.

It is also worth noting that there was a substantial
run-up in oil prices during the six years prior to the Correa administration,
which you use as a benchmark. Oil prices as measured by World Trade Index crude
more than doubled from $30.26 per barrel in 2000 to $66 in 2006.

You state that Ecuador’s fiscal policy has
been strongly pro-cyclical, but again, the evidence presented here is less than
it appears. It is not clear what expenditure data you employ in your Graphs 4A
and 4B. However, if we use real general government consumption, the story changes
somewhat from your presentation:

It appears that your approach suggests
that direct spending on goods and services was indeed running counter to the
business cycle for several years into the Correa administration, if not more
recently. However, the filtering techniques that you used for cycle extraction
are very unreliable ― particularly at the data frontier.[1] In 2014,
for example, both government consumption and output appear to have been running
co-cyclically above trend for several years. However, had we performed the same
analysis at the start of 2015 — based on data through 2014 — we would have
found both had dropped below trend. Within your proposed framework,
policymakers would have — based on real-time estimates— been misled. Such
errors in policymaking resulting from unreliable estimates of trends may even
cause unintentional co-cyclicality. That is, we must allow for the possibility
that pro-cyclical outcomes were not a matter of policy.

On the other hand, we know that the Correa
administration intended to engage in countercyclical fiscal policy during the
earlier downturn. Thus, we forgo trend filtering and take a more direct look at
the expenditure data.

Figure 5 shows total primary
(non-interest) expenditures since 2000.[2] The
monthly data has been seasonally adjusted using STL (Seasonal and Trend
decomposition using Loess), and the resulting quarterly sums adjusted for
inflation using the GDP deflator.

Figure
5: Total Primary Expenditures by Non-Financial Government

Sources: Central Bank of Ecuador and
authors’ calculations

Quarters in which real GDP is reported as
below an earlier peak are marked in gray.

There is a pretty clear increase in the
growth of expenditures around the time that Correa took office. This trend has
stalled or reversed in the last couple years, peaking in the fourth quarter of
2014 — just prior to the start of the most recent downturn. On top of the
general increase in government spending, there was a sharp increase in spending
during the year 2008, peaking with the business cycle in the fourth quarter.

This seems to suggest pro-cyclical policy
during the Correa administration, if not so much prior, but a closer
examination reveals an important complication. Starting in 2008, the
expenditure numbers began including Financiamiento de Derivados Deficitarios
(CFDD) operations.[1]
As petroleum prices have coincided with the business cycle, this has produced
spending cycles that also coincide with the cycle, as we see in Figure 6.

Figure
6: “Other” Primary Expenditures

Sources: Central Bank of Ecuador and
authors’ calculations

It is important to note for purposes here
that such CFDD expenditures are explicitly imports of refined petroleum
products. Indeed, the same fluctuations appear in 2008, when CFDD operations
were added to petroleum income as well. It simply makes no sense to think of
these fluctuations as connected to fiscal policy. They are directly moved by
the price of oil.

Once we remove these “other” expenditures
from the data, much of the increase in trend growth of expenditures vanishes,
and the apparent pro-cyclicality of spending disappears for salaries, direct
purchases of goods and services, Social Security spending, and capital
expenditures ― which, for lack of a better term, we will refer to as
“non-‘other’ primary expenditures.”

Figure
7: Non-“Other” Primary Expenditures

Source: Central Bank of Ecuador and
authors’ calculations

There was still some increase in spending
in the second half of 2008, but the economy had been weakening throughout 2008,
with unemployment rising from 5 percent in December 2007 to 6 percent in
December 2008. It appears that the additional spending in the latter half of
2008 helped stave off the recession.

This illustrates an important point. A
positive correlation in cycles between spending and output does not imply
fiscal policy is pro-cyclical. A perfectly stabilizing policy of countercyclical
spending would not be correlated with cyclical output at all. Likewise, if
countercyclical spending over-corrects for the cycle, then output rises and
falls with spending, rather than the opposite.

If we accept your Graph 4B as valid, then
a 1 percentage point increase in the output cycle is associated with a 2.5
percentage point increase in government expenditures. If we take this
relationship to be fixed as a baseline, then the multiplier on expenditures
will vary inversely with the ratio of trend expenditures to trend output. This, in turn, suggests a path of counterfactual expenditures that would have
stabilized output along the trend.

Therefore, we find that, between the
fourth quarter of 2007 and the fourth quarter of 2008, the stabilization of
output around the observed trend required the government to increase
expenditures from 19.8 percent of GDP to 27.5 percent. In fact, government
expenditures rose from 19.7 to 29.4 percent of GDP. By this construction, in
the first quarter of 2009 — having withdrawn much of this additional spending ―
the government was still overspending by 0.5 percentage points of GDP. If
anything, spending over these early years of the Correa administration suggests
an overcorrection for the business cycle — not pro-cyclical fiscal policy.

You claim that Ecuador’s economy has not
grown especially fast under Correa, objecting to our comparison to the
1980–2006 period, preferring 2000 as a starting point because dollarization
“represents a major structural break.” Ironically, you also cite the effects of
the unusually strong 1997–98 El Nino as damaging to pre-2000 growth. Whether
due to dollarization, El Nino, or other factors, the economy was pretty clearly
depressed at the start of 2000. According to the Central Bank of Ecuador, GDP
in the first quarter was 8.6 percent below its peak in the fourth quarter of
1997. By contrast, Correa inherited an economy less than 0.4 percent below its
peak in the fourth quarter of 2006. This suggests that the potential for growth
from 2000 to 2007 was higher than that from 2007 onward. At worst, the growth
rates for the two periods are comparable.

Similarly, you cite the 1987 earthquakes
as damaging to growth over the 1980–2006 period. This is ridiculous. While GDP
fell 6.0 percent in 1987, it bounced back quickly, growing 10.5 percent in
1988. Likewise, if the effects of the unusually strong 1997–98 El Nino must be
accounted for, then what do we make of the even stronger 2014–16 event? The
fact is, over decades there will be unusual events. There is no obvious reason
to think that 1980–2000 was unusual in this regard.

Sincerely,

James K. Galbraith,
Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of
Government at the LBJ School of Public Affairs, University of Texas at Austin

Ha-Joon Chang,
Department of Economics, University of Cambridge, United Kingdom

William K. Black,
Associate Professor of Economics and Law, University of Missouri-Kansas City

Pavlina R. Tcherneva, Associate Professor and Chair of the Department of
Economics and the Economics and Finance Program at the Levy Economics
Institute, Bard College

Michael Meeropol,
Professor Emeritus of Economics Western New England University

Antonio Savoia, Lecturer
in Development Economics, Global Development Institute, The University of
Manchester, UK

Michael Ash,
Professor of Economics and Public Policy, University of Massachusetts Amherst

[1]This is an account in which the government deposits funds
to cover the cost of importing petroleum derivatives and liquid gas for
domestic use. The unused money in this account is supposed to roll over at
the end of the fiscal year.